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Flashcards in Earnings Per Share Deck (16):
1

Jen Co. had 200,000 shares of common stock and 20,000 shares of 10%, $100 par value cumulative preferred stock. No dividends on common stock were declared during the year. Net income was $2,000,000. What was Jen's basic earnings per share?

  1. $9.00
  2. $9.09
  3. $10.00
  4. $11.11

$9.00

  • Earnings per share is: (net income - preferred dividends)/common shares outstanding.
  • Preferred stock dividends are $100 X 10% X 20,000 shares = $200,000.
  • Earnings per share is (2,000,000-200,000)/200,000

= $9 per share.

2

During the current year, Comma Co. had outstanding: 25,000 shares of common stock, 8,000 shares of $20 par, 10% cumulative preferred stock, and 3,000 bonds that are $1,000 par and 9% convertible. The bonds were originally issued at par, and each bond was convertible into 30 shares of common stock. During the year, net income was $200,000, no dividends were declared, and the tax rate was 30%.

What amount was Comma's basic earnings per share for the current year?

  1. $3.38
  2. $7.36
  3. $7.55
  4. $8.00

$7.36

One year of preferred stock dividends is subtracted from income in the numerator of EPS because the stock is cumulative. The amount of dividends declared does not affect the calculation. The bonds are not relevant because basic EPS does not assume conversion of the bonds. The calculation is: Basic EPS = [$200,000 - (8,000 x $20 x .10)]/25,000 = ($200,000 - $16,000)/25,000 = $7.36.

3

The following information pertains to Jet Corp. outstanding stock for 2004:

Common stock, $5 par value

  • Shares outstanding, 1/1/04 20,000
  • 2-for-1 stock split, 4/1/04 20,000
  • Shares issued, 7/1/04 10,000

Preferred stock, $10 par value, 5% cumulative

  • Shares outstanding, 1/1/04 4,000

What are the number of shares Jet should use to calculate 2004 earnings per share?

  1. 40,000
  2. 45,000
  3. 50,000
  4. 54,000

45,000

The effect of the stock split is applied retroactively to all changes in the number of shares of common stock outstanding before the split.

The weighted average shares outstanding for this firm for 2004 is:

45,000 = [20,000(2) + 10,000(1/2)].

The split affects only the shares issued before date of the split. The July 1 issuance is weighted only by 1/2 a year because the shares were outstanding only 1/2 a year. EPS is computed only on common stock outstanding. The preferred shares have no effect on the computation.

4

Balm Co. had 100,000 shares of common stock outstanding as of January 1. The following events occurred during the year:

  • 4/1Issued 30,000 shares of common stock.
  • 6/1Issued 36,000 shares of common stock.
  • 7/1Declared a 5% stock dividend.
  • 9/1Purchased as treasury stock 35,000 shares of its common stock. Balm used the cost method to account for the treasury stock.

What is Balm's weighted average of common stock outstanding at December 31?

  1. 131,000
  2. 139,008
  3. 150,675
  4. 162,342

139,008

More than one approach is available to compute WA (each yields the same answer) but perhaps the easiest is to weight each item separately going forward to the end of the year. This approach yields 139,008 = [100,000(12/12) + 30,000(9/12) + 36,000(7/12)](1.05) - 35,000(4/12). The beginning shares are outstanding the entire year (12/12). The next two items are weighted for the fraction of the year they are outstanding. Stock dividends and splits are retroactively applied to all items before their issuance - hence the multiplication by 1.05. The treasury shares are removed from the average for 4/12 of the year - these shares already reflect the stock dividend.

5

On January 31, 2004, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend. Both companies issued their December 31, 2003, financial statements on March 1, 2004.

Should Pack's 2003 earnings per share (EPS) take into consideration the stock split, and should Young's 2003 EPS take into consideration the stock dividend?

  • Pack's 2003 EPS
  • Young's 2003 EPS

  • Pack's 2003 EPS - YES
  • Young's 2003 EPS - YES

EPS is used primarily as an input to predictions of future earnings. The stock split and dividend cause the number of shares outstanding to increase, and thus affect the future earnings prospects on a per share basis. These events should be included in the computation of EPS even though they did not occur as of the balance sheet date. Financial statement users view the information as if it were current as of the date of publication.

6

A company had the following outstanding shares as of January 1, year 2:

  • Preferred stock, $60 par, 4%, cumulative - 10,000 shares
  • Common stock, $3 par - 50,000 shares

On April 1, year 2, the company sold 8,000 shares of previously unissued common stock. No dividends were in arrears on January 1, year 2, and no dividends were declared or paid during year 2. Net income for year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31, year 2?

  1. $3.66
  2. $3.79
  3. $4.07
  4. $4.21

$3.79

Basic EPS = Net Income - Preferred Dividends / Weighted shares outstanding.

  • The numerator is $236,000 - preferred dividends [($60 x 10,000) x .04 = 24,000] = $212,000.
  • The denominator is 50,000 (12/12) + 8,000 (9/12) = 56,000 shares.
  • $212,000 / 56,000 = $3.786 or $3.79.

7

Chape Co. had the following information related to common and preferred shares during the year:

  • Common shares outstanding,1/1 - 700,000
  • Common shares repurchased,3/31 - 20,000
  • Conversion of preferred shares,6/30 - 40,000
  • Common shares repurchased,12/1 - 36,000

Chape reported net income of $2,000,000 at December 31. What amount of shares should Chape use as the denominator in the computation of basic earnings per share?

  1. 684,000
  2. 700,000
  3. 702,000
  4. 740,000

702,000

Weighted average shares outstanding are weighted by the number of months the shares were outstanding during the year. The easiest way to do this is to take each change in common stock and multiply by the number of months remaining - add the shares that increased shares outstanding and subtract shares that reduced shares outstanding.

Shares x Months = Wtd avg

  • 700,000 (12/12) = 700,000
  • - 20,000 (9/12) =  15,000
  • 40,000 (6/12) = 20,000
  • - 36,000 (1/12) = 3,000

= 702,000

8

Strauch Co. has one class of common stock outstanding and no other securities that are potentially convertible into common stock. During 2005, 100,000 shares of common stock were outstanding. In 2006, two distributions of additional common shares occurred:

On April 1, 20,000 shares of treasury stock were sold, and on July 1, a 2-for-1 stock split was issued.
Net income was $410,000 in 2006 and $350,000 in 2005.

What amounts should Strauch report as earnings per share in its 2006 and 2005 comparative income statements?

  • 2006    
  • 2005

  • 2006 - $1.78   
  • 2005 - $1.75

For EPS purposes, stock dividends and splits are retroactively applied to all periods presented, and to all share changes within the year of the split or dividend. This procedure ensures comparability.

The 2-for-1 split in 2006 does not substantively change the value of any shares outstanding. Without retroactive application, EPS would be cut roughly in half in 2006 compared to 2005. Yet there was little substantive change in the performance of the firm. For reporting in 2006:

Weighted average shares, 2005 = 100,000(2) = 200,000.
EPS, 2005 = $350,000/200,000 = $1.75.

Weighted average shares, 2006 = [100,000 + 20,000(9/12)]2 = 230,000
EPS, 2006 = $410,000/230,000 = $1.78.

Had the 2005 shares not been adjusted for the split, 2005 EPS would be $3.50 = $350,000/100,000, or roughly double the EPS of 2006. Without retroactive application, it would appear that the firm had a drastic reduction in EPS in 2006. The retroactive application of the split ensures that the base on which EPS is computed uses the same measuring unit.

9

Ian Co. is calculating earnings per share amounts for inclusion in the Ian's annual report to shareholders. Ian has obtained the following information from the controller's office as well as shareholder services:

Net income from January 1 to December 31 $125,000

Number of outstanding shares:

  • January 1 to March 31 - 15,000
  • April 1 to May 31 - 12,500
  • June 1 to December 31 - 17,000

In addition, Ian has issued 10,000 incentive stock options with an exercise price of $30 to its employees and a year-end market price of $25 per share. What amount is Ian's diluted earnings per share for the year ended December 31?

  1. $4.63
  2. $4.85
  3. $7.35
  4. $7.94

$7.94

Weighted average shares outstanding for basic EPS = 15,000(3/12) + 12,500(2/12) + 17,000(7/12) = 15,750. Basic EPS = $125,000/15,750 = $7.94. The stock options are antidilutive because the exercise price exceeds the average market price of the stock. Such options would not be assumed exercised. Under the treasury stock method, assuming exercise would result in more shares being purchased for the treasury than issued upon assumed exercised. The result is a decrease in the denominator of diluted EPS causing diluted EPS to exceed basic EPS. Therefore, in this case, diluted and basic EPS are equal.

10

The following information pertains to Ceil Co., a company whose common stock trades in a public market:

  • Shares outstanding at 1/1 - 100,000
  • Stock dividend at 3/31 - 24,000
  • Stock issuance at 6/30 - 5,000

What is the weighted average number of shares Ceil should use to calculate its basic earnings per share for the year ended December 31?

  1. 120,500
  2. 123,000
  3. 126,500
  4. 129,000

126,500

The stock dividend is considered to be outstanding since the beginning of the year. The weighted average is therefore:

100,000+24,000+ (5,000X6/12) = 126,500.

11

The treasury stock method of entering stock options into the calculation of diluted EPS:

  1. Is used only for dilutive treasury stock.
  2. Computes the increase in common shares outstanding from assumed exercise of options to be the number of shares under option.
  3. Is called the treasury stock method because the proceeds from assumed exercise are assumed to be used to purchase treasury stock.
  4. Assumes the treasury shares are purchased at year-end.

Is called the treasury stock method because the proceeds from assumed exercise are assumed to be used to purchase treasury stock.

Firms may use the proceeds from the exercise of stock options for any purpose. However, to promote uniformity in reporting, and to reduce the dilution from exercise, the assumption is that the proceeds are used to purchase the firm's stock on the market. This reduces the net number of new shares outstanding from assumed exercise.

12

A firm has basic earnings per share of $1.29. If the tax rate is 30%, which of the following securities would be dilutive?

  1. Cumulative 8%, $50 par preferred stock.
  2. Ten percent convertible bonds, issued at par, with each $1,000 bond convertible into 20 shares of common stock.
  3. Seven percent convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common stock.
  4. Six percent, $100 par cumulative convertible preferred stock, issued at par, with each preferred share convertible into four shares of common stock.

Seven percent convertible bonds, issued at par, with each $1,000 bond convertible into 40 shares of common stock.

This security is dilutive. The numerator effect is $49 saving in interest ($1,000 x .07 x (1-.3)), and the denominator effect is 40 more shares outstanding. 49 / 40 = $1.225, which is less than the BEPS of $1.29, so the security is dilutive.

13

For which of the following income statement sections is earnings per share calculated?

  1. Sales.
  2. Gross profit.
  3. Income before discontinued operations.
  4. Dividends paid to common shareholders.

Income before discontinued operations.

Earnings per share (EPS) is calculated on income before discontinued operations, and net income.

14

LM Company has net income of $130,000, weighted average shares of common stock outstanding of 50,000, and preferred dividends for the period of $20,000. What is LM’s earnings per share of common stock?

  1. $2.60
  2. $2.50
  3. $2.20
  4. $0.40

$2.20

Earnings per share (EPS) is calculated on net income available to the common stockholders, $130,000 - $20,000, or $110,000, divided by weighted average shares of common stock outstanding, 50,000. The EPS = $110,000 / 50,000 = $2.20

15

AB Company reported earnings per share of $10.50 on income before discontinued operations, ($2.00) on income (loss) attributed to discontinued operations, and $8.50 on net income. Which EPS figure is more relevant to a potential investor?

  1. ($2.00)
  2. $7.50
  3. $8.50
  4. $10.50

$10.50

Potential investors and current investors are interested in the future earnings potential of the entity. Thus, they are interested in the earnings per share on continuing income, which would be the $10.50 per share. The EPS attributed to discontinued operations cannot be used in predicting future earnings, as they are one-time events.

16

If everything else is held constant, earnings per share is increased by:

  1. Purchase of treasury stock.
  2. Issuance of new shares of common stock.
  3. Payment of a cash dividend to common stockholders.
  4. Payment of a cash dividend to both preferred and common stockholders.

Purchase of treasury stock. i.e. reduces denominator in EPS calculation of NI - Pref. Div. / WAvg. CS Outstanding

Earnings per share is calculated by dividing earnings (profit) available to common stockholders by weighted average number of shares of common stock outstanding. If the denominator is decreased by purchasing treasury stock, then the EPS result is increased.